December 18, 2008

Gasoline Prices

This posting probably won't make me very popular, but I wish people would stop the communist, conspiracy theories regarding gasoline prices. I admit it – I am a complete capitalist. I studied the financial sciences in school, and I believe in letting businesses and people make as much money as they can (within the boundaries of what is legal)... or lose as much money as they can (which seems to be the more common scenario recently).

I, like you, did not enjoy paying $50 to fill up my tank back when gasoline was $4 per gallon. But I also understand that the price of gasoline is not governed by the gas station, nor is it set by the ExxonMobils of the world. The price of gasoline is essentially established by the price of oil, which is based upon global supply and demand fundamentals. When global economies are strong, then the demand (and price) of oil will rise, and when economies weaken (like right now) then the price will fall. It is far from the influence of oil companies.

When gasoline prices ramped up to $4 per gallon, it seemed like everyone was screaming bloody murder. There are ways to try to reduce the price of oil (and, by extension, the price of gasoline), but none of them are a quick fix. (For the record, some of the solutions include alternative energy and promoting the exploration for more oil.) However, many people, including some of my smart friends, were blaming the oil companies for the high gasoline prices, claiming that the companies were raising them, that they were trying to screw us, that they were greedy, that they were gouging us, and why don’t they lower them? That’s not really how it works.

I don't blame people for misunderstanding the complicated economics behind oil prices, and my following comments will be oversimplified, but perhaps they can help clear the record – and point out the inconsistencies of some lines of thinking. Certainly the media isn't going to be responsible and do the job correctly – they are too interested in the television ratings they receive when they rant about gasoline prices... it makes for good six o'clock news.

Gasoline is made from oil, and oil is a fungible, worldwide commodity. Which essentially means that you can move it anywhere in the world (i.e. put it on an oil tanker) and the price is essentially the same. The world's supply and demand set the price of oil (and, therefore, gasoline prices). You can’t sell oil for more than it's worth, because no one would buy it from you... it's too easy to go somewhere else and buy it from someone else. There is too much oil available for purchase in the world from too many different sources, so all these forces balance out and everyone essentially has to charge the same price. ExxonMobil may sounds like an all-mighty empire, capable of controlling oil prices, but they only produced about 5% of the world's total oil in 2007. That is hardly a monopoly position from which to control prices.

So, I hate to burst the bubble of conspiracy theorists, but ExxonMobil wasn't raising the price of gasoline higher and higher to see how much the consumer could withstand. They were charging the fair market price for gasoline – they couldn't charge more, and they couldn't less. (“Couldn't charge less?” Am I sure? Yes. If ExxonMobil charged $3 for a gallon of gasoline when everyone else was charging $4 per gallon, then arbitrageurs would buy all of ExxonMobil's $3 gasoline and immediately start selling it for $4. ExxonMobil would be sold out of $3 gasoline, and the only gasoline in the market would sell for $4. So, no, ExxonMobil really can’t give you a friendly discount. And while ExxonMobil does produce some of its own oil, they also need to buy additional oil from other sources to make more gasoline. That oil they were buying was increasing in price, and oil is a major cost component of gasoline. If they started charging less for gasoline then, at some point, they start to lose money, even at relatively "high" gasoline prices.)

I also laughed to myself when some people complained loudly when gasoline prices went to $4 per gallon, and they blamed it all on the oil companies, but now that gasoline prices have plummeted to below $2.00 per gallon, no one is saying, “Thank you, ExxonMobil! Thank you for lowering gasoline prices and making my life better!” You can’t have it both ways. If you want to erroneously believe that the big, bad oil companies are arbitrarily raising gasoline prices to screw you, then you have to thank them when they “lower” the prices for you, too, right?

Did the oil companies make a hell of a lot of money in the past few years? Heck yeah they did. And consumers and politicians screamed and railed against the oil companies, saying they were making too much money and how it was unfair and there should be a windfall profit tax (an extra tax to penalize a company for making “too much money”). Although oil prices reached $150 per barrel this year, did you know they fell to $10 per barrel in 1999? When oil prices were super depressed in 1999, do you remember giving ExxonMobil a donation to help them out during their tough times? Did you say “Poor ExxonMobil and their horrible profits – it’s such a shame”? No you didn't. So you can’t now say, “Damn ExxonMobil and all the money they are making!”. Once again, you can’t have it both ways. (By the way, I’m not saying you should say, “Poor ExxonMobil” during their tough times... you shouldn't say anything, ever – you should just let them run their business and succeed and fail, and let that be that.) And by the way, oil prices that once were $150 per barrel are now less than $50 per barrel, so there are good times in business and bad times.

The public and politicians may complain that oil companies “make too much money,” and therefore there should be an extra tax or the oil companies should give some of it back... but, theoretically, they already are. Their profits are higher, and therefore they are paying more absolute dollars in taxes to the government because of that. Higher corporate profits generate more tax revenue for the government and, therefore, more money to provide public services and programs. So, high gasoline prices actually are helping the consumer indirectly by providing more corporate taxes to fund government programs (which we all, theoretically, should benefit from).

The oil companies aren't out to “screw us” and the Middle East oil countries aren't out to screw us either. OK, the Middle Eastern countries are “out to screw us” in the way that they fly planes into our buildings, but they aren't jacking with the price of oil to try to hit us in the wallet. Saudi Arabia et al don’t really have the power to control oil prices. It is true that certain countries did form a group called OPEC (which is sort of like a union for oil-producing countries), and they try to control oil supply to help support oil prices, but they historically have been very poor and unsuccessful at doing this.

Also keep in mind that taxes represent a significant amount of the price you pay at the pump. Gasoline taxes vary state by state, but they generally range from $0.50-$0.60 per gallon. That is about 25% of the price you pay for a gallon of gasoline today, and the government didn't have to "make" the product, so it's nearly a 100% profit to them, whereas the oil companies has to pay to find and extract the oil, convert it into gasoline, and then sell it at all the physical locations (gas stations). I would venture to say that, at today's prices, our government is making more "profit" on a gallon of gasoline than ExxonMobil. Of course, things could be much worse. Next time you are filling up your car with gasoline at $2.00 per gallon, keep in mind that gasoline prices over in the U.K. are over $5.00 per gallon (similar to all of Europe because they have very high taxes). Back when we were paying $4.00 per gallon, people in London were paying over $9.00 per gallon!

So, things could be much worse. Sure, oil companies come with their problems, but they also provide and fuel nearly every single great aspect of our modern lives - from transportation to electricity to plastics. So gasoline prices aren't screwing you... what would really screw you is if oil companies failed to supply the 80 million barrels of oil that the world consumes every single day.


  1. im all for green energy! but you make some good points

  2. I agree with a lot of what you say, but higher business profits don't always mean higher taxes paid to the government. There are alot of loopholes!